The Hard Truth About Defaulting On Student Loans

I'm Celeste Headlee and this is TELL ME MORE from NPR News. Michel Martin is away. It's time for Money Coach. That's the part of the program where we talk about personal finance issues. And today, we focus on student loan debt. Americans reportedly owe $1 trillion in student loans. But what happens when so many can't pay or won't pay? Joining us to talk about that is Sandy Baum. She's a senior fellow at the Urban Institute. Sandy, welcome to the program.

SANDY BAUM: Hi. It's nice to be here.

HEADLEE: How big is this problem? How many people default on student loans every year?

BAUM: Well, the first issue is that the trillion dollar number can be somewhat misleading because what really matters is how much individual students owe. And it also really matters whether they owe the federal government or whether they have private student loans. More students have been defaulting in this bad economy, just as more people are defaulting on all of their loans.

HEADLEE: All right. Well, let's kind of pick apart your answer there. Let's talk first about the difference between somebody who owns - gets student loans from the government and those who get a private loan from, say, a bank. What's the difference?

BAUM: If you have a federal student loan, then you are borrowing from the federal government. And if you can't pay, there are provisions. You could be in an income-based repayment plan that guarantees that your payments will not be bigger than you can afford. There are also provisions for deferments, so you don't have to pay if you're in school and you don't have to pay if you can't afford it under forbearance.

If you have a private student loan, it's between you and the bank or Sallie Mae. It's between you and the lender, and they may or may not be cooperative in helping you to defer those payments when you're unemployed or your wages are low.

HEADLEE: I have to assume, Sandy - and I'm a person who is still paying my student loan in my forties - I have to assume that were the restrictions governing student loans not so very tight, that we wouldn't have so many people defaulting. And what I mean by that is you can't get rid of your student loan once you have it, even if you go bankrupt, right? You can't get rid of your student loan.

BAUM: It is possible to get rid of your student loans in bankruptcy, but very, very difficult. And that applies to both federal student loans and private student loans. And you're right that there would be fewer people defaulting if they were dischargeable in bankruptcy. But again, for federal student loans, people really should not have to default if they can figure out - and there are some bureaucratic hurdles - how to get into the appropriate repayment plan.

People with private student loans - and many people borrowed private student loans five or six years ago. Fewer people are doing that now. But those are a bigger problem, and those, if they were dischargeable in bankruptcy, that would make a big difference.

HEADLEE: And the other thing that you can't do, especially for a private loan, is refinance it.

BAUM: Well, some private lenders do allow you to refinance. And the federal government, the Consumer Financial Protection Bureau, is pressuring private lenders to allow students to refinance. But it is very difficult. Students should really think hard before they take those private student loans. And if they already have them, they should negotiate with their lenders. They should seek help from some consumer protection organization if they are struggling with their lenders.

HEADLEE: Let me give you a hypothetical situation. Let's say you have a student who's a few years out of college, lost their job, can't repay their student loan. They are now in long-term unemployment. Maybe they got a deferment without interest for, you know, a year. And that year has been exhausted. They can't pay. What happens to them if they don't pay that student loan?

BAUM: Not paying your student loan is a really bad idea. If you have a federal student loan, they will get that money out of you eventually. They could take it out of your Social Security payments when you get older. You really need to contact the government. You need to figure out how to get into a program that will postpone your payments if you have federal student loans. So defaulting is something that has really long-term consequences for students. It's not easy to get it to go away.

HEADLEE: You just talked about somebody with a federal loan. What if somebody's with a private lender and that private lender is not cooperating?

BAUM: Well, again, the private lender, that's when you need the consumer organizations.

HEADLEE: I see.

BAUM: The federal government, you really can - you just need to know that there are options. You could also go back to the institution where you were enrolled when you took the loans and ask the financial aid office for help. Not paying is really going to hurt you more than it's going to hurt anybody else. And that's true, even if you didn't graduate and even if you feel like your school didn't help you very much. Still, you owe money, if you have a federal student loan, to the taxpayers. And if you have a bank loan, you owe it to the bank. And they don't forget about these things.

HEADLEE: Yeah, I don't think they do. So we know - I mean, you say how bad it is for the student themselves to default. What about the parent or relative who cosigned on that loan?

BAUM: So cosigning a student loan refers only to private student loans because federal student loans don't require either a credit rating or a cosigner. But private student loans usually do require a cosigner. And everyone should know that cosigning a loan is like taking a loan because if you cosign and the student doesn't pay, you are responsible for that loan as though you had borrowed the money yourself. So parents should not cosign loans unless they are in a position to repay because they will have exactly the same problems that a student who can't repay would have.

HEADLEE: So when you saying exactly the same problems, if you're a parent, they could be garnishing your tax refund or your Social Security benefits?

BAUM: The garnishing is easier for the federal government to do than for private lenders to do. But you cannot discharge a student loan in bankruptcy. So whether you're the parent or the student, that's going to apply to you. One of the things that happens to people is that they've borrowed $10,000, and then they don't pay. And there is interest that accrues, and there are penalties imposed for nonpayment. And then they find that they owe 20 or $30,000. And that can happen to the cosigner, as well as to the original borrower.

HEADLEE: What groups tend to default more? I mean, my assumption - purely uneducated - is that it's probably young people who are having trouble finding a job. Is that correct?

BAUM: Actually, the people who default the most are people who dropped out of college without a credential. And part of that is because they have more trouble getting jobs. And part of that is because they don't really see why they should pay. And, you know, one thing that happens is, if you have a car loan, you know they're going to take your car away from you if you don't pay. So, many people pay their car loans first, and then they don't pay their student loans. So people who have accumulated other forms of debt also are likely to struggle with their student loan payments.

HEADLEE: How did we end up in a situation where student loan debt is treated so differently than any other kind of debt?

BAUM: The issue is why is student loan debt not dischargeable in bankruptcy. And one thing that's important to realize is that while it would be better if student loan debt were dischargeable in bankruptcy, you really don't want to get to that point. It's not a good thing to declare bankruptcy. So the question is really, why do people struggle to repay their loans? And one answer to that is that, first of all, most people don't. Some of the headlines would make you think that everybody borrows to go to college and that everybody who borrow struggles.

The reality is that a lot of people actually graduate from college without debt, and most of those who borrow borrow reasonable amounts that don't cause them trouble. But too many students do borrow more than they can afford to repay. And there's a lot of lobbying that goes on. So why are private student loans not dischargeable in bankruptcy? Because the lenders have a lot of power in Congress, and they lobbied for that.

HEADLEE: To go a little further into this, I know a personal friend of mine who had no idea the difference between a private and a federal loan. When she was signing her paperwork, nobody was really clear on that. And she ended up with an 8 percent rate which she cannot refinance, and there's no way to get rid of that debt. I mean, I would imagine that, for many people, that becomes - I mean, that's more than a car payment. You're getting up towards your mortgage payment when you start paying that off.

BAUM: Well, of course, if there were other kinds of loans available at lower interest rates, you could take another kind of loan and use the money to pay off your student loans. So no one...

HEADLEE: You mean like a personal loan...

BAUM: Yeah, no one can...

HEADLEE: ...Or a second mortgage.

BAUM: You can always prepay your loan. So that's really not that much of a problem. Although it would be better if you could refinance. In terms of whether people are confused, it used to be that you could get a federal student loan through a bank or through Sallie Mae and also a private student loan from them. And so it was much more confusing.

Now all of the federal student loans are direct loans from the federal government. So if there's a bank name on it, if there's a Sallie Mae name on it, then you know that is a private student loan and you want to be extra careful. It is much better to finance your education without taking those loans. But it's fine to take federal student loans.

HEADLEE: OK, so for the people that were already grandfathered in, they're kind of out of luck.

BAUM: Well, yes. If you've already taken a loan and you didn't know what you were getting, then you're already in that situation. And it's really good to get some personal advice about how to organize your finances, which loans you want to repay when. Maybe you have another kind of debt that you could refinance, and that would make it easier for you to repay your federal or your private student loans.

HEADLEE: Sandy Baum is a senior fellow at the Urban Institute, and she joined us from NPR's New York bureau. Sandy, thank you so much.